Since unveiling his strategy to reduce the UK’s yawning budget deficit in 2010, George Osborne has faced immense pressure to change tack. In a replay of Margaret Thatcher’s first-term battle in the early 1980s, an alliance of Keynesian economists and the Labour opposition has accused the government of choking off growth. The prophets of doom predicted years of stagnation with soaring unemployment and falling living standards.
After a run of positive economic data, Mr Osborne has reason to feel vindicated. As party conference season approaches, he therefore seized the opportunity this week to proclaim the economy was “turning the corner”. Since the austerity policy was still under way, claims that a “Plan B” was necessary to trigger a recovery had been proved wrong, he argued.
Mr Osborne has won the political argument. True, Britain’s gross domestic product is still 3.2 per cent below the pre-crisis peak. But the current acceleration looks like the beginning of a sustained recovery. In the three months to June, the economy expanded by a healthy 0.7 per cent. Business surveys from all sectors are at record highs, meaning that GDP is expected to rise by a further 1.5-2 per cent in the second half of 2013. New orders are running at a good clip – a sign that the recovery still has some way to go.
The anti-austerians grumble that the upturn would have come earlier had Mr Osborne eased up on the fiscal squeeze. This is impossible to prove as economic history offers no counter-factuals. What we do know, however, is that the chancellor’s critics overstated the obstacles standing in the way of a recovery. Their position was too extreme and they have found themselves snookered.
Nor was Mr Osborne ever the wandering axeman of opposition caricature. He showed flexibility in allowing the automatic stabilisers to work in order to absorb negative shocks. The chancellor repeatedly pushed back the year by which he intended to balance the structural deficit, adjusting when it became clear the economy was weaker than he expected rather than cutting faster to compensate.
Mr Osborne’s Treasury was hardly to blame for Britain’s prolonged downturn. Households took longer than expected to shrink their borrowing. This damped domestic consumption, as did the spike in commodity prices, which made goods more expensive. The crisis in the eurozone – Britain’s main trading partner – penalised exports and depressed animal spirits. These headwinds have now receded, thanks partly to the European Central Bank’s intervention to stabilise the euro. Growth has returned.
None of this means the government’s economic record has been impeccable. Infrastructure spending was cut too far. Since roads and railways drive long-run productivity, the price will be paid over many years. The coalition’s courage in tackling the deficit has not been matched by an equal daring in unshackling the supply side of the economy. Byzantine planning laws hamper construction. Restrictive immigration rules put an illogical cap on talent. These policies will continue to do harm, even in the upturn.
Mr Osborne now faces two risks. The first concerns the quality of the recovery. In his speech, the chancellor dismissed fears that the UK was experiencing the “wrong sort of growth”. He argued that the upswing was balanced across sectors and that credit-fuelled domestic consumption was playing a lesser role than during the pre-crisis boom. But while manufacturing is making a comeback, the export numbers still look terrible despite sterling’s steep depreciation. There are also concerns that Britain may be inflating another housing bubble, thanks partly to the subsidies offered via the chancellor’s Help to Buy scheme.
The second risk touches on who benefits from the recent spurt of growth. Labour has been quick to redraw the political battle lines around falling living standards, claiming that the recovery must be turned to the advantage of working families.
Here, Mr Osborne looks more vulnerable. Business confidence is strong, but companies are not hiring much. Inflation is high, squeezing the purchasing power of stagnant wages. While there is little governments can do to rein in the cost of living, voters will give the chancellor less credit for his competent macroeconomic management if their pockets are empty.
Yet the very fact that the debate has now shifted to how the fruits of growth are shared is a victory for Mr Osborne. Having been vindicated on his toughest call, this is a political fight he should relish.
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